Bank of Canada Should Hold Overnight Rate at 1.75 Percent through October, Hike to 2.00 in a Year’s Time Says C.D. Howe Institute Monetary Policy Council

April 18, 2019 – The C.D. Howe Institute’s Monetary Policy Council (MPC) has recommended that the Bank of Canada keep its target for the overnight rate, its benchmark policy interest rate, at 1.75 percent at its next announcement on April 24, 2019, and maintain it at that level through the end of October. The MPC also recommended that the target rise to 2.00 percent by April of next year.

The MPC provides an independent assessment of the monetary stance consistent with the Bank of Canada’s 2 percent inflation target. William Robson, the Institute’s President and CEO, chairs the Council. Council members make recommendations for the Bank of Canada’s upcoming interest-rate announcement, the subsequent announcement, and the announcements six months and one year ahead. The Council’s formal recommendation for each announcement is the median vote of the members attending the meeting. When, as on this occasion, the median is in the middle of a 25-basis point range, the mean of the votes breaks the tie.

The call for maintaining the overnight rate this week and for the next announcement in May was unanimous. For the October announcement, nine of the ten members attending the meeting called for no change, and one called for an increase to 2.00 percent. Looking ahead to April 2020, five members called for an overnight rate unchanged at 1.75, four members called for a rate of 2.00 percent, and one member called for a rate of 2.25 percent (see table).

The complexion of the conversation at this MPC meeting was mixed: more optimism about the current and near-term outlook; more caution about the longer-term outlook, and consequently about the level of the overnight rate that would be “neutral” – consistent with activity growing in line with the economy’s productive capacity and inflation steady at 2 percent. The better near-term tone reflected both more confidence about the global outlook and recent encouraging indicators of activity in Canada. The caution about the longer-term reflected in large part the growing evidence that the low overnight rate of the past several years (the rate has been below the Bank’s 2 percent inflation target for a decade) has not supported the economy and inflation as much as previous experience would have suggested.

MPC members tended to think the Canadian economy was recovering from a weak close to 2018, but did not expect robust growth of spending and activity for the balance of this year. An overstretched consumer, policy measures that have damped the housing market, and continued disappointments in exports and business investment all figured in this subdued outlook. On the supply side, members cited slow capital formation and weak productivity growth, noting that the economy’s productive potential will also grow slowly, implying little if any disinflationary output gap, and inflation continuing close to the Bank’s target.

Under these circumstances, many members judged that the current overnight rate is not much below, and may even be at, its neutral level. A couple of members speculated that the next recommendation for a change in the target might be a recommendation for a cut. So while the group as a whole leaned slightly toward a higher target in a year’s time, none recommended an increase before the fall.

Votes of MPC members and the Council median for each announcement, percent